Gold: Assumptions vs Reality

One of the hardest things to do as an investor is to think through investments without presuming anything. The data will tell a story and paint a picture for you that you can then interpret. Most people shun this obvious approach to investing and instead choose to invert the process by allowing their assumptions to cloud their analysis. This is simply not a sophisticated approach to investing.

A combination of history and quantitative data analysis will give you a perspective that 95% of investors do not have. For example, most people alive today have not lived through the gold exchange standard, and therefore have no clue how it functions. To most, it is a peculiarity of our ancestors; a relic of the past; and a product of a crude economic system. They cannot imagine the possibility of gold playing a role in the global monetary system. Their knowledge of history is small, and so is their sense of economic possibilities.

It is presumptuous to assume that gold will not eventually play a role in the international monetary system since it happened before in history. It is also presumptuous to assume sovereign nations will not default since sovereign defaults are prevalent throughout history. Most of the anti-gold arguments are based on assumptions that simply aren't true. Here are a few.

Jewelry Demand?

It is incredibly difficult to argue with someone who pulls the "jewelry demand" card on you. Why? The jewelry demand argument is so false that its defenders are invariably a special breed of stubborn. You can never win these kind of arguments.

Now as investors, let's test the assumption that there is some kind of relationship between jewelry demand and gold prices. As you can see below, if there is a relationship, it is a negative one.

If you invested based solely on an assumed relationship between gold and jewelry demand, you would have lost money 9 out of the past 10 years. While the data suggest we should change our assumptions, most people won't. This is the irrationality of human nature at play that allows a minority of investors to profit.

Investment Demand, Anyone?

The real demand is coming from institutional investors, retail investors, and governments. Chinese, Russian, and Indian central banks have recently become major buyers. This is a positive trend for gold since these governments hold so small a percentage of their reserves in the form of gold. Since the dollar dominates foreign reserves, diversification into gold equivalent to dumping dollars.

Retail investors have also begun to protect themselves from spendthrift governments. Objectively speaking, retail investment is a far better indicator of gold prices than jewelry demand.

Marginal Demand, Human Irrationality, and Gold

A fundamental tenet of economics is that humans act rationally. Why I have no clue. Nothing in my experience has shown that people act rationally and to their best interest at all times.

Understanding human irrationality is central to understanding the future price movements of gold. For example, are people more likely to buy gold at $250 dollars after 20 years of being the most hated asset in the world or at $2500 dollars? You don't see lines around the block at gold shops at bottoms; they are an indicator of tops. This is a reflection of both gold's unique marginal demand characteristics and the nature of bubbles in general.

The marginal demand aspects of gold run contrary to those of most other assets. Generally speaking, a rise in price results in a decline in demand. For gold, a rise in prices results generally in an increase in demand. This is its natural state. Add to the mix human irrationality and the panic buying that is bound to come and you start to understand that the monster moves in gold are still ahead.

Financial experts are telling us the gold trade is crowded. Ironically, gold will become a crowded trade only when the "gold bubble" experts start buying. Not to be flippant, but this is one of the top 3 indicators I'm looking for to signal a top in gold. Fortunately, the gold bubble experts are still out in force expounding on the threats of deflation- an argument so riddled with holes that it should not be taken seriously. Making linear comparisons between fixed exchange and floating exchange systems is like comparing apples and oranges: It makes no sense and it is bound to result in flawed conclusions.

We should all try to test our assumptions against facts. That most investors don't is great news for gold bulls. We are on the precipice of a major move in gold that will make all blind assumptions concerning gold look foolish.

That is incorrect. The fundamental tenet of economics is that people respond to incentives. Their responses are often expected to be well informed and rational but there is no assumption that they need be so.

There isn't going to be a top because this is not a bubble, and to speak of it in terms of the current market paradigm is indicative of ignorance and a lack of imagination.

The old ways are collapsing and a new age is upon us. Fiat currencies will ultimately be considered for what they are: worthless ethereal digital blips or printed pieces of paper.

Think of a large body of water nestled in a great canyon, kept in place for millenia by a ridge that is now weathered and crumbling. One day, lightning strikes and hits just the right keystone and the ridge gives way. The large body of water is now a torrential river escaping out into the countryside wreaking havoc and reshaping the landscape where ever gravity takes it. Finally, it settles, the former lake having drained to a puddle, while its water is now a series of smaller lakes and rivers throughout the valley.

There is no returning the water to the great lake high up in the mountains. It has given way to a new environment and there's no going back. The creatures that stayed or got trapped in the former great lake are doomed to extinction, while the ones that rode the rapids will settle and ultimately prosper in their new evirons.

What is with this disingenuous "argument", such as it is, that constantly brings up a VERY brief price spike as some sort of iron-clad reference point? Do you realize how FEW people bought gold at that peak in 1980, and how many fewer were not daytraders who probably did not own it past the next day or week? Really, it is all but meaningless to even bring up, except as an example of a mania --- a mania that was a flash in the pan as well.

I bought two Krugerrands only about 16 months before that peak, at just under $200 an ounce, and I am still nicely ahead on them, even accounting for the intervening inflation and devaluation of the US dollar. THAT is a much more relevant example.

Lawrence, you are naively assuming (as I originally did) that this JohnnyCowardo is trying to engage in honest or sincere debate. However, his purpose here is nothing of the sort, but merely to antagonize, flame, attack, harass and insult anyone who is a proponent of owning gold. Trying to hold a meaningful discourse with him has been repeatedly shown to be a fool's errand, as he will just evade or deflect any logical arguments or challenges to his anti-gold trolling (which, by the way, he has freely admitted is his intention here on more than one occasion).

I cannot judge the merits of any argument of yours, as you have never deigned to make any here --- you just maliciously attack, ridicule, flame and harass the advocates of gold over and over and over and over, like the despicable troll that you are.

"There isn't going to be a top because this is not a bubble, and to speak of it in terms of the current market paradigm is indicative of ignorance and a lack of imagination."

You beat me to it, Chumba, and took the words out of my mouth.

Yes, I strongly suspect that anyone looking at gold (and maybe silver too) as being in some sort of bull market or typical asset cycle are going to greatly surprised by upcoming monetary events over the next few years. This is almost certainly NOT a "gold bull market" we are seeing, but a reintroduction of gold into the world monetary system. As such, any predictions based on TA or other standard market analytical tools are fundamentally meaningless in this context.

Gold needs no reintroduction to the world monetary system because it never left. It is only the continuing redeemability of paper gold (government bonds, bullion bank notes, gold futures etc) that has kept the existing monetary system alive for so long.

Central banks have been loaning their gold reserves for years, keeping the gold circulating. Don't believe me? Check the link at the bottom of this article;

Of course, you are correct, on a much more fundmental level than that of my prior comment. Perhaps I should have originally stated that gold is increasingly being reacknowledged as part of the world monetary system instead.

Exactly ... this is a systemic change, not another market variation. And gold doesnt even meet any of the criteria of bubble. So forget the banker bubble blather that bamboozle bozos and buy blissfully bullion. Another shot please.

"Nothing says rational like everybody agreeing with each other that the gold price will increase by 4000%."

I seem to have missed that conversation. In fact, you have a knack for referencing such non-existent statements, agreements and factoids --- like your "$2000 gold by June" prediction that 69% of those here did NOT make or agree with!

If you are going to lie, and repeatedly, you might want to create falsehoods that are less easily disproven:

Chumba is kind of metaphoring fofoa's idea that gold at some point (soon?) will very quickly move to its historical role of being the best wealth protector (msg to Geoff just below).

$3000? $5000? $20,000? $55,000? $100,000? Who knows? I hope we can meet up, gents above, when we get to $50,000... I promise not to talk about Middle East stuff... But, we CAN talk about guns if you want!

If gold ever reaches or exceeds, say, $25,000 an ounce (in today's dollar terms), I say we hold a national ZeroHedge convention and celebration somewhere to toast the new paradigm, and our good fortune. After all, ANYONE holding more than an ounce or two of gold will be able to afford it!

akak, I believe I already invited you to the party that Gordon_Gekko and I first agreed to in order to have a few drinks to celebrate if/when gold sets to $50,000 / oz (close enough to fofoa's $55,000 average probability price). Chumba said he wanted to come too (I believe he said: "Phuck yeah!". As did Hulk, RockyR and a few others.

Hulk wanted a party at $1500, but I told him 1 drink only, and at home.

$50 k we should all meet somewhere central (meet me in St. Louis?) and have a raucous fiesta baby! I promise no Middle East talk though. Guns, yes. ZeroHedge and gold haters, yes.

Bravo you're welcome to come, I will not harm you at all, but I cannot say what the fanatics will do...!

I am going to invite fofoa too, it was HIS prediction that gold will LEAP to the moon as gold returns to its historical role: best wealth protector there exists.

We will buy the road warriors off with 1/10 oz. Maple Leafs, maybe even some silver Eagles or MLs. Of course, we'll still need one of those armored gasoline tankers to get there. We can let Johnny come along and ride on the roof. It'll be pretty uncomfortable in the wind and the rain, but I hear that suffering is good for the soul. (That's presuming one has a soul, I guess.)

Never been to St. Louis; Chicago would be a great rendezvous too. It would be awesome to meet you guys, and relive the bad ol' days of fiat! Yes, GG, FOFOA, Nuinut, Rocky, Hulk, Chumba, maybe we can even invite Peter Schiff, Ron Paul, James Turk, Ted Butler, John Embry, Eric Sprott, and Jim Sinclair, and make it a REAL bash!